Italian Yields Soar as Summit Enthusiasm Fizzles Out

By Neelabh Chaturvedi

It looks like investors have already run out of patience.

Italian bonds are getting pulverised Monday. The five-year Italian bond yield is trading at 5.95%, the highest it has ever been since the inception of the euro. The 10-year yield has climbed above the psychologically important 6% level, a level that in the past portended a sharp slide in government bond prices of other fiscally frail countries.

The world, or at least the euro zone looked like a happy place after European leaders said they’ll beef up the region’s rescue fund, the European Financial Stability Facility, and an agreement on a “voluntary” write-down that bond investors will take on their Greek holdings was reached. The lack of details are now hampering sentiment.

At the heart of the problem is a distinct lack of confidence. Despite a raft of measures announced by the Italian government and secondary market purchases by the ECB, investors are still shunning Italian bonds.

Unless bond market participants can be emboldened to buy Italian and Spanish bonds, the euro zone debt crisis may yet run for a little while longer. Italy and Spain are much larger economies than Greece, Ireland, and Portugal—all three of which had to seek external assistance—and should they suddenly find themselves unable to borrow at affordable rates, the European Financial Stability Facility’s fire fighting capabilities will be severely put to the test.

In Italy for example, coupon payments and bond redemptions alone total €167 billion next year.

According to Richard McGuire, senior interest rate strategist at Rabobank, the crisis has moved from fundamentals of individual countries to a systemic one, whereby each country pursues a different fiscal policy but the ECB sets monetary policy for the entire region.

“Unless we see debt risk transferred to the weaker countries, either directly in the form of common issuance or indirectly in the form of guarantees, the crisis may continue,” he said.

However, the bar for a common bond for all euro zone countries is high. While weaker countries would love to ride the coattails of their stronger neighbors and bring down their borrowing costs, Germany and France remain reluctant.

With the euro zone set for a marked slowdown in economic activity, selling the idea to an angry electorate may just become harder.

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